After the storm, look for these stocks to shine

Before Hurricane Irene swept onto the East Coast of the U.S. and began battering houses and trees and buildings, the powerful storm was already battering property and casualty insurers' stocks.

With government officials predicting widespread property damage, many stocks in the sector plummeted on the assumption that insurers would be on the hook for huge payouts.

The Irene-driven fears were the latest turbulence to hit the insurance industry. The financial crisis, U.S. health care reform and a very active 2010 hurricane season have all caused investors to question the prospects for the sector.

In the case of Irene, the fears turned out to be worse than the reality. In the case of insurance stocks, investors' anxiety may also prove to be overdone.

David Dreman, the Toronto-born investment manager who heads Dreman Value Management in Jersey City, N.J., has conducted research that suggests investors' penchant for overreacting to negative news makes contrarian investing a profitable strategy. Focus on beaten-down stocks that have solid fundamentals and balance sheets, and you can find some stocks poised for big rebounds.

I base my investing strategies on the work of gurus such as Mr. Dreman. Right now, several of my strategies are pointing to insurance stocks that investors have been overly sour on. (Keep in mind that it can take time for the market to warm up to contrarian plays, so you need to have a strong stomach for this type of investing.)

Erie Indemnity Co. : Based in Erie, Pa., the company is part of a larger group that has agents in 11 states and the District of Columbia. The group focuses on auto, homeowners and small commercial lines.

Erie gets a solid 83-per-cent score from my Dreman-inspired model, which considers it a "contrarian" pick because its price-to-cash flow and price-to-book ratios both fall into the market's bottom 20 per cent.

Unloved stocks like this are worth the risk if their fundamentals and financials are strong. Erie's earnings per share have been climbing and its pretax profit margins are nearly 20 per cent, two good signs. It's also yielding 2.8 per cent while paying out about 31 per cent of its profit, far below its historical average of 73 per cent. That's a sign it could raise its dividend payouts.

Reinsurance Group of America : Missouri-based RGA is one of the largest re-insurers in the world. It focuses on life insurance and gets about two-thirds of its premiums from the U.S. and Canada, but is active on six continents. It recently announced that it would be raising its dividend payout by 50 per cent.

I wrote about Reinsurance Group last October, and since then it's up about 11.5 per cent. My Peter Lynch-based model is now high on the stock, which it considers a "stalwart," the type of big, steady company that Mr. Lynch found offered protection during downturns. My Lynch-inspired model likes the company's low price-to-earnings ratio, especially in combination with the firm's solid growth rate.

Prudential PLC : This London-based firm is active in life and property and casualty insurance. It also offers financial services such as fund management.

Prudential is one of the few stocks in the market that gets strong interest from my John Neff-based strategy. Neff liked companies producing sustainable growth with cheap shares; Prudential's low price-to-earnings ratio (8.2) and moderate 16.4-per-cent long-term earnings-per-share growth rate fit the bill.

Mr. Neff was also a big believer in the importance of dividends. He developed the total return/price-earnings ratio, which adds a stock's earnings-per-share growth rate to its dividend yield, and divides by its P/E. Prudential, which is yielding 4.2 per cent, has a total return/PE of 2.52, almost four times the market average – a great sign.

Sun Life Financial Inc. : This 146-year-old Toronto-based firm, which is involved in life, health, dental and medical insurance, as well as wealth management services, gets a high ranking from my James O'Shaughnessy-based value model.

Like many financials, Sun Life has had a bumpy few years, but it did well in 2010 and has continued to perform decently in 2011. Given the performance of its shares, investors don't appear to be giving it its due. The O'Shaughnessy model likes Sun Life's large size, $4.05 in cash flow per share and hefty 5.5 per cent dividend yield.

Disclosure: I'm long Erie, Reinsurance Group and Prudential.